Top gold producers force investors to hedge bets
biz.yahoo.com
Friday October 9, 6:53 pm Eastern Time
By Paul Simao
DENVER, Oct 9 (Reuters) - Barrick Gold (Toronto:ABX.TO - news) Corp. and Newmont Mining (NYSE:NEM - news) Corp., North American's two largest gold producers, benefited recently from a modest improvement in the bullion price, but they offer starkly different philosophies on how best to profit in the notoriously volatile gold sector.
Canada's Barrick hedges, or sells forward, most of its gold production, while its Denver-based rival Newmont prefers greater exposure, and more risk, to swings in the gold price.
Hedging, a common practice in the gold industry, allows a company to cushion the effect of a falling gold price by selling future production at a fixed price. Such a move can pay handsome dividends in an environment where confidence in gold is declining, as it did during the past year. But hedging can backfire if gold moves in the opposite direction.
Gold has stabilized near the psychologically important $300-an-ounce level after touching an 18-year-low around $270 an ounce this past summer. Falling international equity markets, the near collapse of a seemingly infallible U.S. hedge fund and a sharply weaker U.S. dollar have prompted nervous investors to buy a stake in both bullion and gold stocks.
Barrick, considered the best hedged gold company in the world, is a true believer in the value of what it calls its ''revenue maximization program.''
The Toronto-based company has already sold the lion's share of its production over the next three years with 10 million ounces of gold hedged at a price of $400 an ounce through to the year 2000. Barrick's hedge position would net about $750 million above the spot bullion price if it were closed out today and remains a compelling reason for consistent profitability despite declining gold prices.
''Barrick was the probably the first company in the gold industry that started the program of hedging its production and we've been doing so consistently for about 10 years. It started off as a relatively simple, straight-forward program, but over the years the company has become increasingly knowledgeable and has more understanding of the tools available to it in order to get the highest price for gold,'' Barrick Chief Executive Paul Melnuk told Reuters during the Denver Gold Group's annual conference this week. ''Frankly, I cannot see any downside.''
Hedging has generated more than $1 billion in additional revenue relative to the spot price of gold over the past decade. It delivered an additional $73 million to Barrick's bottom line in the second quarter of 1998, allowing it to post earnings of $67 million, or $0.18 a share.
Barrick's shares closed down C$1.65 at C$32.70 in Toronto Stock Exchange trading of more than 2.4 million shares.
But Barrick's innovative hedging program also has a built-in safety system in the event the price of gold rises above the average price of the company's hedges. Owing to its strong financial position, flexible credit lines and long-term commitment to hedging, Barrick has the option to defer, or roll forward, its hedging contracts by up to 15 years and deliver its future production into the open market.
The company earns interest, estimated at about $200 million per year, on its future gold deliveries.
''With that degree of comfort, the discipline we bring to the program and what we've been able to do in terms of earning a premium return from gold hedging, we don't think anybody has a track record like we have,'' said Barrick Chief Financial Officer Randall Oliphant, who oversees the hedging program.
''It's not the kind of thing you can just start doing or learn from reading a book,'' Oliphant added.
Unlike its Canadian rival, Newmont has shown a strong aversion to hedging its gold production. About 30 percent of Newmont's production in 1997 was hedged at above market prices and the mining giant estimated that figure would decline to about 20 percent in 1998.
Newmont is philosophically opposed to hedging most of its production, which it believes would limit its ability to benefit from an improving gold price. Critics have attributed falls in Newmont's share price this year on its relatively small hedge program.
Newmont shares closed down 3 11/16 to 25 5/8 on the New York Stock Exchange on Friday, with more than 2.4 million shares changing hands.
Although the decline of gold this year has made Newmont somewhat ''envious'' of better-hedged gold producers, the company believes its shareholders want exposure to any possible rise in bullion prices, Newmont Chief Executive Ronald Cambre told the Denver Gold Group on Friday. ''We think the gold price will improve and markedly so,'' said Cambre in defense of the company's ''largely unhedged'' position.
Newmont expects to produce about 4 million ounces of gold at a cash cost near $180 an ounce in 1998, falling slightly to between 3.6 and 3.9 million ounces at a cash cost between $180 and $190 an ounce next year.
Gold analysts agree that choosing Barrick or Newmont depends on investors' risk tolerance and confidence in gold.
''It's a trade-off between the two. If you really want some good exposure to any upside move in gold and want a high-leverage play, I think you go for Newmont given the lack of hedging and debt they have. They have a very good fundamental outlook,'' said Douglas Cohen, an analyst at Morgan Stanley Dean Witter in New York.
''If you want to be a little bit more conservative and perhaps sleep a little better at night, Barrick is still the marquee name in the industry. It has the hedge position, the balance sheet and the strong management you take some comfort in. It doesn't mean that it won't move with the gold price, but at least there's more of a cushion,'' Cohen said.
($1=$1.54 Canadian) |
